tv Bloomberg Real Yield Bloomberg August 5, 2017 10:00am-10:30am EDT
♪ jonathan: from new york city for our viewers worldwide, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, the u.s. payrolls report delivers. jobs increase more than expected and unemployment drops to a 16 year low. former fed chair alan greenspan says there's a bubble, but not in equities. it's in bonds. hertz leaves investors flying blind. the auto company gives bond traders the silent treatment. we begin with a big issue. a solid jobs report in the united states. >> this is a very fine report. >> these are good numbers.
>> this is a rather strong economic report, but i don't think it moves markets much. >> the unemployment rate ticking down, labor force ticking up, rates beating expectations. i think the recovery is continuing. >> until we see a look back at 2% in terms of that core inflation rate, the fed probably begins quantitative tightening, but won't raise short-term rates this year. >> the one thing that we are not seeing that was commented on is wage inflation. why are we not seeing wage inflation despite the fact that the economy is strong? >> we obviously would love to see wage inflation in the system. wage inflation means we are putting more income into consumers' pockets. when consumers have more income and we lower the tax rates on top of that, they will have more money to spend, driving more and more economic growth, so that's what we really want to see. jonathan: joining me around the table is michael collins, the head of global interest rate strategies at td securities,
priya misra, and joining us from california is nick maroutsos, a portfolio manager at janus henderson investors. let's begin with you, priya, and talk about the federal reserve. it's a solid jobs report, but it does not move, doesn't it? priya: they are almost not really data dependent, but for the hike in december, i think it does move the needle. i know the market didn't react as much, that you are seeing signs of the labor market slack going away. and most importantly, we saw signs of wage inflation picking up. so, all of this week and -- all of this weak inflation data that we have had the last three or four months, they can afford to ignore it if wage inflation is picking up. this is one off prices, but wage inflation is picking up and it allows real incomes to rise. i think the probability of a december hike, which was already 5%, i think we are looking at at least 50%. and the reason i'm not higher than 50% is i want to see how they deal with portfolio runoff.
if financial conditions remain remarkably easy, i think they might begin a hike in december. michael: i think they should hike. if i were them, i would hike in september before i start tapering the balance sheet. right, because our view has been the more that they taper the balance sheet, or reduce the balance sheet, it's effectively a tightening of monetary policy whether they want you to believe that or not. and the further that goes, it lowers the probability they will be able to hike. i think they should get as many bullets in their chamber as they can so that they can cut in the next recession. jonathan: i look at the job report and it looks at one more hike this year. the unknown seems to be next year. morgan stanley is looking like four more interest rate hikes in 2018. we put that question earlier this week and he said good luck with that. there seems to be a huge spread with what to expect from the fed next year given we don't know who the fed chair will be. there's a lot of unknowns coming up, isn't there? nick: that is absolutely right. i think we are in an environment of unknowns.
if we look at the fed, let's look at their track record. in 2016, they projected four interest rate hikes and they did one. in 2017, they projected roughly -- three and they are on a path to maybe achieve that. unlikely to take the under of that relative to what priya and michael are saying. so, if we look at 2018 as a guide, our guess is that the fed is likely to underdeliver, typically of what they have done previously. priya: we have to think of the hiking cycle as a normalization. i think we have to think of this as a normalization. i think when the fund rate is 1.5%, 1.7%, your real rate is essentially zero. now, we are going into the tightening more, we will see it hike a few more times. what is our start actually rising? the people calling for four hikes say you want to actually tighten. i'm not so sure. jonathan: i'm looking at the dot
plot and the federal reserve gravitates toward the market. nick, earlier this year the market was actually led by the fed very briefly. it just feels like the federal reserve has lost conviction over the last couple of months on their own forecast. do you anticipate the dot plot , so to speak, is about to gravitate down toward the market's view of the world? nick: it has to and that's a matter of fact. i mean, if you look at what forecasting has done over the past quarter of a century, the markets have consistently got the market wrong in the sense that they projected rates to be higher. in most cases, rates finished lower throughout the year. i'm talking overall rates and not just the cash rate. we are in an environment where we live in a world of doves. let's look at the market environment. you have data that is weak, inflation that's weak, walking back on hawkish remarks, moving off potential rate hikes. you know, accommodation is here
to stay. while we may be unwinding it over time, it's going to take time. that's what people need to realize. a lot of people are calling for the bond bubble to end or pop. we are not there yet. we are in an environment where there will be lots of accommodation. it is going to remain and rates will stay relatively range bound for the foreseeable future. michael: the neutral funds rate is not plus two as it used to be many decades ago when we were trying to get inflation lower. now we think we will be in environment over the next 5, 10, 20 years where we will try to get inflation higher, fighting deflation. the real neutral funds rate is negative one to one right now, meaning the nominal funds rate to three.y at zero and i think you're in the middle of that right now. i think three is a really tight policy that would drive us to recession. jonathan: we are trying to work out what the economic data means for the federal reserve and the policy means for market.
a lot of people would sit at this table and over on the trading floors and say these things no longer matter. earlier this week, it really struck me. it looks like the russia probe is deepening in the eyes of a few investors and the curve flattens. and when the curve fall flattens, there's still some upside risk expected on the long end from what we might get from d.c. do we need to fade all that out? priya: and the equity market and the risky asset market, there's absolutely a lot of that trump premium priced in. it's not just taxes. i think it is taxes and deregulation. what you can have is that gets derailed, if you get more tape bonds, i think in equities there are a lot of downsides. -- if thatbuy happens? we are buying further out of the curve because there's a lot more yield. i think it derails the fed hike cycle next year if you have that much dysfunction. jonathan: you look at a 30 year and at the start of the year, people would say that would go materially higher. is that actually a buying opportunity in some regards?
nick: i look around the world and i say, ok, u.s. yields stick out. and the reason being is that you have japanese yields that are yielding roughly 10 basis points. you have german bunds yielding roughly 50 basis points. foreign demand is going to consistently go out and purchase bonds whether it's in the 30 , year part of the curve or the 10 year part of the curve, as an foreign investor, i'm licking my chops. i am happy to get that percent if i can. globally if i'm sitting in my own country and i'm running 10 basis points, i think there will be a natural pull of rates keeping down, even though some of the data proves rates areup. we will be an environment where data stays range bound. priya: i think the one points here that has potential risk y, does the treasury come out with 20 or 50 year bonds. if the issuance and the treasury tries to fund the fed portfolio, the issuance which we think
levels out to 5%, i absolutely agree with nick that that there is value. there is a risk that the treasury decides to extend the maturity a lot more. there's always demand from the rest of the world, but at what price? maybe you want a little more price of supply. jonathan: do you really think the average maturity is going to change with treasuries? we look at it now and it's 70 something months. the u.k. is 160 something months. michael: if i were an issuer of debt or a borrower of money, i will want to be on the front end of the curve because consistent with our view that the fed will not hike that much. the lowest yields will continue to be at the front of the curve. i think it is expensive to issue on the backend, especially if you issue a 40 or 50 year at a premium to where the 50 year trades. jonathan: michael collins, priya misra, and nick maroutsos will be staying with us. coming up next, the auction block erupts, proving the thirst for risk in yield is very real. you are watching "bloomberg real yield." ♪ ♪
jonathan: i'm jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now where there is an appetite for long dated bonds. last week, at&t. this week, gm. the automaker sold $3 billion in bonds. the longest portion of the four-part offering was a 30 year with 2.55 percentage points above treasury. united states treasury says it will maintain the issuance of longer-term debt at $62 billion. officials continue to be studying the introduction of ultralong bonds and predicted borrowing needs to increase as the fed continues to shrink its
balance sheet. elsewhere, an eye-catching debt sale back got a lot of people talking. iraq sold $1 billion of bonds due in 2023 have yield of 6.75%. investor demand was massive. orders almost seven times the issue size. some in the market pointing to this iraqi offering as a warning sign of a potential credit bubble, a debt bubble. a bubble is something that former fed chair alan greenspan spoke about this week. he told bloomberg by any measure that real long-term interest rates are much too low, therefore unsustainable. when they move higher, they're likely to move reasonably fast. we are experiencing a bubble, just not in stocks, but bonds. this is not discounted in the market price. with me to discuss is michael collins, priya misra, and nick maroutsos. priya, what is a bond bubble? what is that? how do we define it? priya: a bubble essentially would be you have got fundamentals and pricing that is widely different. i would argue there is no bond
bubble. unlike equities where you have a string of cash flow. it is harder to see it in bonds. but we have a series of cash flows in bonds. and if i would argue the reason i don't think there's a bond bubble is that if you look at the funds rate, if it is going to end at 1% -- and our view is closer to 2%, but if the funds rate ends at 2%, is not really much of a bubble on a 10 year. absolutely, the fed hiking cycle component of that, which is markets pricing fairly, the other part is demand from the rest of the world. that is significant. if you tell me that mario draghi will be extremely hawkish and bunds will be higher, sure. but is that a bubble or re-pricing? i will disagree with this idea, but there are views across the board. jonathan: here is how i think about it. how we look in 10 years when we look back 10 years? how will we look at that massive bulk of bonds? with a negative interest rates from nowhere how will be think , about these governments who
managed to issue all that debt with zero interest rates? are we going to look back at them and say, what on earth? michael: one perspective is in 10 years we will look back and say i wish i bought more of these long-term treasury bonds at almost 3%. right? because somewhere between now and that 10 years, we are going to have a recession. in that recession, our 10 year isn't going to be at 2.25%, it will be at 1.25%. our fun right will be at zero or even it will be a roller coaster negative. ride between now and then. i'm looking at alan greenspan. i feel he's having a flashback. he was talking about stagflation the other day. stagflation is when you have weak economic activity and high inflation. we have the opposite. we have strong economic activity and modest inflation. he is talking about real yields need to be positive, i think that is the world we lived in again. in the future, real yields on risk-free assets, i don't think they should necessarily be positive. priya: i agree with you entirely. the 10 year question depends a lot on inflation. if inflation is a lot higher, absolutely these prices are
mispriced, but i'm not so sure with technology and the gig economy that these bonds are becoming larger and larger and the share of the labor is declining. i'm not sure inflation is really about to take off. jonathan: nick, the story of a bond bubble of the idea that argentina could come to the market and issue a century bond , that greece has come to the market and got debt away at a decent yield, and a rock -- and iraq has an offer seven times oversubscribed. when people comes to you with those issues, what do you say to them about your own thoughts? nick: i think there's massive complacency in the market place. we have this insatiable thirst for yield, there are lots of uncertainties and people are engaging in risky behavior. why? they are trying to replicate returns of yesteryear. they are trying to get those 5%, 6%, 7%, 8% returns. how do you do that? you have to move down the credit spectrum or move down the maturity curve. when you look at iraq, iraq is looking at themselves and saying, let's get into this game, and why not? is a perfect addition to issue new debt and lock in low rates. let's look at where we were two years ago.
iraq tried to issue debt in 2015, but there was a decline in oil revenue and war with the islamic state. there was government instability and the market was pricing somewhere around 10%. they did end up issuing about a billion last january, but that was u.s. government guaranteed. two years later what we found is greed trumps risk. people are so thirsty for yield and there's this fear of missing out, that like you said, it is seven times oversubscribed and 3% tighter. i'm not saying that's inappropriate, but if there is a flight to quality, i will not say it's to iraqi bonds. like they have been saying, greenspan is essentially doubling down on comments made two years ago. the reality is the stock bubble is a result of a bond bubble. welcome to the magical world of quantitative easing. jonathan: absolutely, and i think many people watching this program would agree with you. michael collins, i think the way that you look at it right now, there are many things rough in credit and maybe it's time to load up on softens.
michael: it looks like at this point in the cycle -- you can argue it's getting late in the cycle. and it's not late in the cycle. it feels to us that a lot of investors are piling into credit. they are going down in quality. you hear a lot of talk about private debt. they're going down returns. in capital structures and doing things you're not supposed to do later in the cycle to get that extra yield. we are definitely going the other way. we are definitely upgrading the credit risk in our portfolios, reducing exposure. jonathan: does that include buying a greece type issue? michael: in some cases, it does. in some cases we are reducing exposure to corporate credit risk. there is a tremendous amount of churn happening within each industry. it feels like this pricing pressure, which means the inability of companies to raise prices, is spreading across a variety of industries, and it's causing problems there. so, we are fading that. you look at greece and you can argue that they are fundamentally improving. that in three years from now, they will probably have higher ratings than they have today.
jonathan: to be on the periphery that is brave. ,mike? michael: i think they will pull back really slow. if you think the fed tapering is like watching paint dry, the ecb has to get down to zero purchases, which could take a year or year and a half. and then they have to figure out how to get that -40 basis point yield to zero. which could be more years. jonathan: michael collins, priya, and nick staying with me. let's get you a market check of where bonds have been this week. yields lower on the long end. we are down by five basis points on the 30 year. unchanged on the 2-year note. 10 year creeping down three basis points on the week so far. still had, the final spread. the week ahead featuring bond investors looking for answers from hertz. we will get that in just a moment. this is "bloomberg real yield." ♪ ♪
jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. coming up over the next week, opec and non-opec members will be meeting in abu dhabi to discuss compliance with production cuts. and mexico rate decision and data, and -- u.s. cpi earnings from of all places, hertz. you might ask why we are highlighting hertz this week. the company disclosing that it was not going to use the proceeds of a recent sale of senior debt to buy back existing subordinated bonds as it had previously indicated. hertz did not give a plan for what it was going to do from the senior bond sale just two months ago. still with me as michael collins, priya misra, and nick maroutsos from janus henderson investors. in the consumer discretionary space, this is the most traded debt. the volume of it is ridiculously high.
everyone's talking about it in the credit space. if someone put that credit in front of you now, what would you say back to them? michael: it's highly traded because it's exciting and there's a lot of news and a lot of volatility. the markets are looking for a volatile story they can trade around a little bit. in light of the low volatility environment. earlier this year, there was reduced exposure to the auto rental space, auto rental asset backspace, and even the auto space and the auto supply space to some extent because it looks like that whole sector has maybe already peaked this cycle. jonathan: nick, your thoughts? nick: i would agree with michael. i am a bond investor and i am looking at capital protections, some form of income generation. i want some stability in my portfolio where we can collect ively accrue income on an ongoing basis and sleep at night. we are not the type of people that will be chasing returns. i think that is what is happening in this environment.
you are seeing more more people and more and more issuers issue debt and lock in low levels of rates and people are willing to buy that because they need return. jonathan: the auto sector has been fascinating for many people in the credit guys are trying to find what the trade is to play up the back of it. i think the guys in macro are looking at treasuries and all of a sudden thinking about auto sales. there is some kind of read through as to the strength of the consumer. what are you thoughts right now? priya: the market has reacted to the weaker numbers. if you look at my terminal, you see the auto sales seasonally adjusted annual rate. which has been falling off. now, i can -- we expected it. with higher replacement value of cars, people are not moving and changing cars that often. that 18 million was a pretty high number. it has been falling off, but i think what the markets are now worried about is that you have a fed that is tightening and normalizing. you have inflation not looking that hot. what if growth is falling off as well? they are using any leading indicator and this is the leading indicator of consumption. jonathan: mike, let's be clear. you are not reading that chart
and looking at a weak consumer, do you? or is it weak for this specific space in credit? michael: i think the consumer is in a great spot still. the consumer is pretty solid. that being said, the underlying trends among consumers is changing pretty quickly. i had a meeting yesterday with a bunch of young women just entering the workforce. i said, do any of you have cars? absolutely not. millennial's generally do not own cars. it's a different environment for consumers products companies. like i said, there's a lot of churn and things going on. but there are a lot of other sectors you can pull up. housing to some extent looks like it may be is a little toppy. construction looks a little toppy. job gains looks like that chart we just saw. jonathan: where going to wrap up the program with a rapidfire round. we wrap it up into three questions with one word answers please. lowflation forever or stagflation around the corner? to you first, michael. michael: lowflation. priya: lowflation. nick: ditto, lowflation.
jonathan: if greenspan was a trader, would you take the other side? michael: yes. priya: i would. nick: absolutely. jonathan: would you buy the 2023 iraq bond or the hertz note of a similar maturity? michael: well, maybe the iraq bond. priya: the iraq bond. nick: wow, that's a tough one. i would probably stick with the u.s. and go with hertz. jonathan: going to leave it there. michael collins, priya misra, and nick maroutsos. from new york to our viewers worldwide, you are watching "bloomberg real yield." ♪ we check our phones 85 times a day.
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